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Are You Under-Banked?

Are you under-banked? If so, you’re not alone. A recent article I read indicated that among CFO’s, being under-banked has landed on the growing list of challenges most CFO’s face. Here’s why: 

  • A recent report stated that the financial landscape for small to medium sized businesses (SMB’s) has changed significantly. 

  • Credit markets have become increasingly biased toward bigger businesses
  • 89% of SMB’s report having the enthusiasm to execute growth strategies, yet just 52% have the necessary financial resources to successfully do so. 

  • The National Small Business Association reports that 31% of small businesses are without the capital they need. That translates into over 10 million businesses nationwide. 

So, what does under-banked really mean? And how do SMB’s get creative to find the capital they need? 

Traditional banks rely on the credit worthiness of the SMB (not the owner) to determine when and how to lend, and at what rate. With pressure from the regulators after the passing of the Dodd-Frank Act, banks have been tightening commercial lending standards again.  

With lending from commercial banks hard to find, many are seeking financing from alternative capital sources, as banks struggle to compete in that space. Here are some alternative sources to consider: 

  1. Asset-based lending: ABL is lending against the value of the collateral, not the balance sheet, of the business. It’s expensive (often overall cost between 18-24%). Most ABL lenders will advance between 80-90% of accounts receivable, depending on the quality of the receivable.  
    They often will use a lockbox where all your AR comes into a lockbox to the lender (which is unknown to your clients). That way, they can control advances and payments to your line of credit. The monitoring required is fairly heavy. An ABL lender will charge a service fee for administration, typically 1-1.5% per month, and will charge interest at Prime plus 3 (give or take 1%) for the period of time the money is outstanding. 
  1. Non-Bank SBA lenders: To fill the gap in the SBA lending space vacated by banks, several non-banks that are privately funded will do SBA loans on similar terms to banks. They don’t have the same regulatory reporting/pressure that banks receive, so they are less conservative than many commercial banks.  
    If you’re buying a business, the SBA provides a 10-year amortization and can typically finance about 80% of the business subject to an appraisal. There are SBA programs that also finance up to 90% of commercial real estate on favorable terms. 
  1. Private Debt and/or Equity: Many individuals or family offices are tired of receiving less than 1% on their short-term money accounts or mutual funds. So, they are willing to allocate a portion of their wealth toward investing in business ventures. This is high-risk lending because these businesses can’t receive credit from other sources. However, the returns are high (typically in the 18% range) and there’s a fee to the person or company that raises the money.  
    Some of these sources will also require a portion of the company (referred to as an equity kicker). This is common when a company is in a growth phase and will sell to a strategic buyer or do an IPO. The equity kicker provides an increase in the overall return due to the increase in value they received from the stock at the sale. 

Given an environment where available sources come in all shapes and sizes, the smart choice may be to seek an experienced advisor that knows the market and can create the best outcome for you and your company. 

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